Cannabis industry is one of the fastest growing segments of the U.S. economy. At the beginning of this year, 36 states plus the District of Columbia have legalized marijuana for recreational or medicinal use, or both. However, marijuana is still considered a Schedule 1 controlled substance under federal law. This creates a number of tax compliance issues for the cannabis/marijuana business owners. This article gives an overview of some of these issues.
Reporting Gross Income / Cash Transactions
The Internal Revenue Code does not differentiate between income derived from legal sources and income derived from illegal sources. See Internal Revenue Code § 61. It’s all income and is taxable and must be reported on your tax return. Furthermore, because marijuana is listed as a U.S. Schedule 1 drug, many businesses do not or cannot participate in the U.S. banking system and conduct transactions in cash. If a business in the cannabis/marijuana industry receives more than $10,000 in cash in a single transaction or in related transactions, they must file Form 8300, Report of Cash Payments Over $10,000 Received in a Trade or Business, within 15 days after receiving payment. Business owners really must be diligent about this. The penalty for negligent failure to timely file, to include all required information or to include correct information is $280 per return, not to exceed $3,392,000 per calendar year. IRC Section 6721(a)(1). The penalty for intentional disregard of the requirement to timely file or to include all required information, or to include correct information is the greater of: (1) $28,260 or (2) the amount of cash received in the transaction, not to exceed $113,000 (with no calendar year limitation applicable). The penalty applies to each failure. IRC Section 6721(e)(2)(C).
Deduction of Expenses
Internal Revenue Code section 280E disallows all deductions or credits for any amount paid or incurred in carrying on any trade businesses that consist of illegally trafficking in a Schedule I or II controlled substance. This applies to businesses that sell marijuana, even if they operate in states that have legalized the sale of marijuana, because trafficking marijuana remains illegal under the federal Controlled Substances Act. United States v. Oakland Cannabis Buyers’ Co-op., 532 U.S. 483 (2001). Accordingly, section 280E disallows all deductions or credits for a business that sells or otherwise traffics marijuana. N. California Small Bus. Assistants Inc. v. Commissioner, 153 T.C. 65 (2019).
Accordingly, a marijuana dispensary may not deduct, for example, advertising or selling expenses. It may, however, reduce its gross receipts by its cost of goods sold, as calculated pursuant to Internal Revenue Code section 471. Section 280E does not prohibit a participant in the marijuana industry from reducing its gross receipts by its properly calculated cost of goods sold to determine its gross income. The Internal Revenue Service takes the position that section 280E affected taxpayers must calculate their cost of goods sold pursuant to Internal Revenue Code section 471 and the associated Treasury Regulations. Generally, this means taxpayers who sell marijuana may reduce their gross receipts by the cost of acquiring or producing marijuana that they sell, and those costs will depend on the nature of the business.
Different Treatment Under California Law
Because of the marijuana legalization in California, the state takes a different approach for deduction of expenses for the California state tax purposes. Section of 280E of the Internal Revenue Code does not apply. Licensed taxpayers may deduct cost of goods sold, and ordinary and necessary business expenses on their California returns. Unlicensed business can deduct cost of goods sold, but not other business expenses.
Employment Taxes and Sales Taxes
Cannabis businesses have no exemption from their employment tax obligations, and as with other small businesses, they often need to make quarterly tax payments. These business owners should always pay their taxes on time to avoid interest and penalties.
Beginning January 1, 2018, California has two new cannabis excise taxes:
15% Excise tax imposed upon purchasers of cannabis and cannabis products. Retailers of cannabis and cannabis products are required to collect the 15% tax from the purchaser based on the average market price of any retail sale and pay it to their cannabis distributor.
A cultivation tax is imposed upon cannabis cultivators on all harvested cannabis that enters the commercial market. Cannabis cultivators are required to pay the cultivation tax to either their distributor or their manufacturer.
Distributors must collect the cannabis excise tax from retailers and the cultivation tax from cultivators or manufacturers.
Enforcement Efforts
The IRS has made tax enforcement in the cannabis industry one of its top priorities. The government is aware that there are taxpayers operating in segments of the industry (growers, transporters, wholesalers and retailers/dispensaries) who fail to file U.S. tax returns. These business owners should be aware that non-filers are an IRS enforcement priority. Tax agents also have become more adept over the past decade at enforcing Section 280E of the Internal Revenue Code, which prohibits the use of standard business deductions by any company that traffics in federally controlled substances. Another of the top enforcement priorities in the cannabis industry is the use of cryptocurrency. Those who use it need to understand that the IRS considers it property, and there are gains that are taxable.
Do you have any questions about compliance with tax requirements? The Former IRS Attorneys of Holtz, Slavett & Drabkin, APLC can review your situation from an IRS perspective and advise on how to fix these tax problems before the IRS contacts you. We can be reached at 310-550-6200 to schedule a consultation.